ADTRAN's CEO Discusses Q4 2013 Results - Earnings Call Transcript

|
 |  About: ADTRAN, Inc. (ADTN)
by: SA Transcripts

Operator

Ladies and gentlemen, thank you for standing by, and welcome to ADTRAN's fourth quarter 2013 earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer period (Operator Instructions).

During the course of the conference call ADTRAN's representatives expect to make forward-looking statements, which reflect management’s best judgment based on factors currently known. However these statements involve risks and uncertainties, including the successful development and market acceptance of core products, the degree of competition in the market for such products, the product and channel mix, component costs, manufacturing efficiencies and other risks detailed in our Annual Report on Form 10-K from the year ended December 31, 2012, and on Form 10-Q for the quarter ended September 30, 2013. These risks and uncertainties could cause actual results to differ materially from those forward-looking statements, which may be made during the call.

It is now my pleasure to turn the conference over to Mr. Tom Stanton, Chief Executive Officer of ADTRAN. Sir, please go ahead.

Thomas Stanton

Thank you, Steve. Good morning everyone. Thank you for joining us for our fourth quarter 2013 conference call. With me this morning is Jim Matthews, Senior Vice-President and Chief Financial Officer.

I like to begin this morning by discussing the details behind our Q4 results, and I'll end with some comments on what we see for the future. As stated in our press release, revenues for the quarter were $159.1 million. Our Carrier Networks division revenues came in at $126.2 million, an increase of 14% over the same period the prior year. The Broadband Access category led this increase growing 26%, bolstered by a strong performance from our international business.

Our Enterprise division Q4 sales totaled $32.9 million, about 13% over the same period last year. This growth in Enterprise was driven by our Internetworking category, which on a combined product basis, including both Enterprise and Carrier products, grew 27% year-over-year. The total company domestic revenues came in at $107.2 million, with International revenues coming in at a record $51.9 million.

On a product basis, our core product areas, which include Broadband Access, Internetworking and Optical achieved $142.9 million in revenue, an increase of 25% over the prior year and representing a record 90% of total company revenues. More specifically, Broadband Access achieved $88.6 million in revenue, an increase of 26% over the same period last year, supported by international strength in EMEA and Latin America and a solid performance here in the U.S.

The U.S shipments of our Broadband Access products overcame their normal seasonal trend, with the help of a sequential increase in shipments to several Tier 2 customers, as we continue to see the benefit of market share gains within the market. Also during the quarter we saw a substantial increase in GPON shipments to Carrier customers in the U.S., including increases to Tier 1, Tier 2 and Tier 3 carriers. This increase benefited both our Broadband Access and Internetworking category.

Our main performance was helped not only by continuing shipments of vectoring technology under existing awards of the adoption of our vectoring technology by additional carriers in the region.

Moving on, our Internetworking product category came at $40.3 million. Growing 27% over the prior year helped by increasing GPON ONT shipments as previously mentioned and by growth in our business Ethernet access, Ethernet switching and IP gateway products.

From a channel perspective we yet again had another solid recruitment quarter, adding a net of approximately 60 new partners to our dealer base. Speaking of the VAR channel, we did see a year-over-year revenue decline through VAR channel distribution for the quarter, which was more than offset by year-over-year increase in both NSP and CSP channels.

Our Optical revenue saw year-over-year growth of 14% coming in at $14.1 million in revenues, helped by increasing Broadband related shipments and increasing market acceptance of our optical network-edge products where we added seven new carrier customers for the quarter.

Looking at the business on a geographic basis, as I previously mentioned, we saw strong activity in EMEA and Latin America. This activity was not only with our traditionally strong customers, but with emerging customers as well. Looking forward into this year, we expect activity in this region will continue to grow as carries both in the Telco and MSO space move forward on implementation plans revolving around ultra-Broadband utilizing vectoring, GPON and active Ethernet technologies.

In the U.S., sales to carriers for the quarter remained essentially flat to last year, with a decrease in legacy products being offset by increases in our core product areas. As a side note, HDSL sales for the quarter were $8.5 million, representing a record low 5.3% of total company revenue.

Moving forward into this year we continue to progress with our major Tier 1 award here in the U.S. and although exact timing of these type of awards often change, we expect revenues to begin early in the second half of this year.

In the U.S. Tier 2 and 3 markets, we believe the USF to CAF transition continues to hold promise. We are encouraged by the capital changes that occurred at the end of 2013, which helped ease the uncertainty around funding the multi-year projects and we look forward to the implementation of CAF Phase 2, which will provide additional motivation for Price CAF Carriers to upgrade their infrastructure.

Finally, as I’ve mentioned on previous calls, we believe our market share and geographic expansion is timed well with carrier cycle associated with the rollout of high-speed access. We continue to see accelerating activity as carriers around the world embrace next-generation access technologies to strengthen their competitive positions and meet their customers growing demand.

I'd now like to turn them to Jim Matthew to review our results for the fourth quarter 2013 and our comments for the first quarter 2014. We’ll then open the call up for questions. Jim?

Jim Matthews

Thank you Tom and good morning everyone. Revenue for the fourth quarter increased to $159.1 million compared to $139.8 million for Q4 of 2012. Broadband Access product revenues for Q4, 2013 increased to $88.6 million compared to $70.1 million for Q4 of 2012. Internetworking product revenues for Q4 2013 increased to $40.3 million compared to $31.6 million for Q4, 2012.

Optical product revenues for Q4, 2013 increased to $14.1 million compared to $12.3 million for Q4, 2012. Carrier Systems revenues for Q4, 2013 increased to $108.7 million compared to $90.1 million for Q4, 2012.

Business Networking revenues for Q4, 2013 increased to $41.2 million compared to $33 million for Q4, 2012. Loop Access revenues for Q4, 2013 were $9.2 million compared to $16.7 million for Q4, 2012.

HDSL product revenues for Q4, 2013 were $8.5 million compared to $15.6 million for Q4, 2012. As a result of the above, Carrier Networks division revenues for Q4, 2013 increased to $126.2 million compared to $110.8 million for Q4, 2012.

Enterprise Networks division revenues for Q4, 2013 increased to $32.9 million compared to $29 million for Q4, 2012. International revenues for Q4, 2013 increased to $51.9 million compared to $29.2 million for Q4, 2012.

To provide the reporting of each of these categories, we have published them in our Investor Relations webpage at adtran.com.

Gross margin was 48.3% of revenue for Q4, 2013 compared to 46.5% for Q3, 2013 and 48.2% for Q4, 2012. The sequential improvement in gross margin for the quarter was primarily attributable to improved gross margins in the acquired Broadband Access business.

Total operating expenses were $66.2 million for Q4, 2013 compared to $65.3 million for Q3, 2013 and $64.5 million for Q4, 2012. The increase in operating expenses for Q3, 2013 was primarily attributable to the increase in R&D expenses and increase in sales and marketing expenses. The increase in operating expenses from Q4, 2012 to Q4, 2013 was primarily attributable to the increased sales and marketing expenses. Acquisition-related amortizations totaled $700,000 for the quarter.

Stock-based compensation expense, net of tax was $2.2 million for Q4, 2013 compared to $1.9 million for Q3, 2013 and $2.2 million for Q4, 2012. Supplemental information for acquisition-related expenses, amortizations and adjustments in connection with the recent acquisitions are provided in our operating results disclosure.

All other income, net of interest expense for Q4, 2013 was $3.7 million compared to $2.8 million in Q3, 2013 and $3.5 million for Q4, 2012. The company's income tax provision rate was 17.3% for the fourth quarter of 2013 compared to 18.9% for the third quarter of 2013 and 38.2% for the fourth quarter of 2012. The lower tax rate for the fourth quarter of 2013 compared to the fourth quarter of 2012 largely relates to significantly improved profitability of the acquired Broadband Access business.

Earnings per share on a GAAP basis assuming dilution for Q4, 2013 were $0.20 compared to $0.28 for Q3, 2013 and $0.06 for Q4, 2012. Non-GAAP earnings per share for the quarter were $0.25 compared to $0.32 for Q3, 2013 and $0.11 for Q4, 2012.

Non-GAAP earnings per share exclude the effect of acquisition-related expenses, amortizations and adjustments related to acquisitions and stock compensation expense. The reconciliation between GAAP earnings per share diluted and non-GAAP earnings per share is provided in our operating results disclosure.

Inventories were $90.1 million at year-end compared to $93 million at the end of Q3, 2013 and $102.6 million at the end of 2012. Net trade accounts receivable were $85.8 million at quarter end, resulting in DSOs of 50, compared to 56 DSOs at the end of Q3, 2013 and 53 DSOs at the end of Q4, 2012.

Unrestricted cash and marketable securities net of debt totaled $408 million at quarter end after paying $5.2 million in dividends and after repurchasing 850,000 common shares for $20.1 million. For the year we repurchased at total of 5.6 million shares for $124.3 million.

Due to the book-and-ship nature of our business and the timing of near-term revenues associated with large projects, it is our policy not to give specific guidance for the quarter or for the year. However, we would like to give color to help formulate your views on our near-term business outlook.

For the first quarter of 2014 we expect total company revenues will be in the range of flat to down mid-single digit percentage point range on a sequential basis. We expect GAAP gross margins will be range with gross margins experienced in Q4, 2013. We expect GAAP operating expenses for the first quarter will be in range with OpEx levels experienced in the fourth quarter of 2013.

We anticipated a higher tax rate in the first quarter due to a less favorable customer mix and slightly lower revenues in the acquired business and the delay in legislation to extend the research tax credit for 2014. We expect the consolidated tax rate for Q1 to be in the mid-30’s percentage point range to pretax income.

We believe the larger factors impacting the total revenue we realized for the fourth quarter of 2013 to be the following: The macro spending environment for carriers and enterprises; professional services activity levels, both domestic and international; the timing of revenue related to Broadband Stimulus and Connect America projects; and the adoption rate of our Broadband Access platforms. Tom.

Tom Stanton

Thanks Jim. Steve, we are ready to open it up to questions now.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Rod Hall from JP Morgan. Your line is open.

Rod Hall - JP Morgan

Yes, good morning guys. Thanks for taking my question. I just wanted to check a couple of things. I guess first of all, maybe if you could talk a little bit more about the, what do you mean by gross margins in range in Q1? I mean what sort of a range would you put around the Q4 gross margins, just so we can get some idea for what the variability there might be.

And also I’d be curious to know if you could talk a little bit about your Tier 1 commentary, which is similar to I think what you said last quarter on an H2 start for the revenues. But can you just give us a little bit more on now that we said at the beginning of 2014 what is gating the start of that? What are the particular factors that drive timing and what might make it start sooner and what might make it start later? So that will be helpful.

And then also if you could just update us on what’s going on in Europe with large carriers over there, just give us a little bit of color on how things are progressing and what you would expect here in the first part of the year. Thanks.

Jim Matthews

Well, this is Jim; I’ll address your first question. So in terms of the gross margin in Q1, we think about it as flattish, lets call it that. Obviously there will be some level of variation, but it should be in a fairly sort of small range so to speak, a fairly tight range. So I think flattish would characterize our view on that. Does that help?

Rod Hall - JP Morgan

Yes, that’s great. Thank you, Jim.

Tom Stanton

Yes, this is Tom. As far as the progress with the carrier here in the U.S., I guess what I was really trying to say is that there’s really been no significant change in timing from where we were a quarter ago.

If you look at the different things associated with the project like this, there is typically lab testing and things which has all gone well, but long pole and it tends to be OS integration and that is integrating all the management capabilities that are inherent with any particular application or system into the legacy OS’s that the different carrier may have and that’s always long pole and that is actually the gating item here. So it’s just a matter of work that has to be done on the customer side predominantly in order to be able to manage these systems in a large-scale rollout.

Rod Hall - JP Morgan

And maybe Tom, can you comment on where you said it’s the main gating item, I mean what is there – are there any particular road, marketing points that would, that you could talk to us about that will either accelerate or slow down the process of integration.

Tom Stanton

Well yes, and I guess I can, but I don’t know if it will really help you there. I mean the big things that we tend of look at, is at lab entry of equipment, which now what we are talking about with this particular carrier is several, many different applications actually and all of that is on track. We delivered a significant amount of equipment, definitely what is initially going to be deployed and that set of equipment will grow over time, so all that’s on track.

The real key here is for the carrier to be able to maintain their schedule on integration and there is really not a good way for us to have significant insight to that, other than if it gets off the track we will typically find out. But right now I know that’s nothing that would say that its off track and I think we are right on track from where we were hoping to be at this point.

Rod Hall - JP Morgan

And can you comment on Europe a little bit?

Tom Stanton

Sure. I mentioned that the vectoring technology. So Europe actually, we had a fairly good quarter and that quarter was actually driven by several things. One, we do have a large carrier there that started rolling out in the second half of last year, we had a strong third quarter and a strong fourth quarter with that carrier and we expect that to continue on and we should see some ramp of that as we keep coming. We hit our stride there this year, but we also picked up a couple of other customers in Europe that have now adopted a vectoring technology, and want to say – if you let me say EMEA, that’s probably more inclusive of what I’m talking about.

So there’s still, there is definitely a strong demand. We have trials going on with several other customers in that region right now and for our vectoring technology. So we expect this to be a good year from a customer acquisition perspective. Of course it takes time to get these to rollout, but I’m encouraged by the fact that we’ve already got a couple more that we started shipping to in the fourth quarter.

Rod Hall - JP Morgan

And how do those new customers compare in terms of size to the first big, the initial big customer that’s start of last year over in Europe?

Tom Stanton

They are smaller. I mean and a lot of times its because the geography is smaller. I would say our footprint or our market share with at least one of those customers is just as large, but the region itself is just smaller. So, I don’t expect the same magnitude of ramp. There are a couple of very large ones that we are engaged with. In fact we have lab trials going on with one of them, but they are further out. But the one that we are dealing with I think is at least from my current perspective that largest limits that’s happening right now, so.

Rod Hall - JP Morgan

Okay, that’s great. Thank you very much.

Tom Stanton

Okay.

Operator

Our next question is from Sanjiv Wadhwani from Stifel. Your line is open.

Sanjiv Wadhwani - Stifel Nicolaus

Thanks. Jim on gross margins, obviously a nice improvement compared to September. You had an up-tick in December, expecting flat in March. Can you just sort of talk about how we should model progression of gross margins through the course of the year. Are we still on track to sort of see that up-tick in the back half of this year?

And them a quick question on competition. You mentioned that you had a good Tier 2 quarter Tom. It looks like there was some share gains in that quarter. I was wondering if you could give any more specifics around that and also recently there was some articles about maybe Huawei starting to get a little more interested in targeting Tier 3s in the U.S. market. Just wondering if you can give us some thoughts around that too. Thanks.

Tom Stanton

Sanjiv, Jim. In terms of your gross margin question, we do see our gross margins as we go through 2014 improving, particularly in the second half. So we certainly do continue to believe that second half gross margins will be improved over first half as we continue that progression.

Sanjiv Wadhwani - Stifel Nicolaus

Got it.

Tom Stanton

As far as the Tier 2, we actually, we did have a good quarter in the Tier 2’s. If I look at the Tier 2 market place and look at the make up of that market place, I think the majority of our Tier 2 customers, like I know the majority of like Tier 2 customers that we saw a sequential increase, which is not typical, and we used to see a decrease from third to fourth quarter, so we are just fairly solid.

Some of it was Broadband stimulus related and then others were just market share gains. Now some of these market share gains are things that are just coming to fruition. I talked earlier in 2013 about us winning some additional accounts and picking up additional applications in market or footprint within some of these accounts and some of that is just really now starting to come online. So I think that’s one of the reasons that we – that we saw the increase.

Sanjiv Wadhwani - Stifel Nicolaus

Any thoughts on Huawei?

Tom Stanton

Yes, I read what you read. I have talked to our sales force about that. We haven’t seen a big impact, at least in the filed yet. Really I know that they are hiring people, but we haven’t really seen a strong push that’s really affected us in any way. I don’t see them in any bids and winning any bids that we are involved in.

I tell you, it’s fairly early in that, at least in the announcement cycle for them and I’m slightly confused as to from week to week whether or not they are in or out of the U.S. market. But we haven’t seen an impact yet.

Sanjiv Wadhwani - Stifel Nicolaus

Got it, that’s helpful. Thanks.

Tom Stanton

Okay.

Operator

Our next question comes from Amitabh Passi from UBS. Your line is open.

Amitabh Passi – UBS

Thank you. Tom I just wanted to clarify a comment you made. I thought you said you had a good fourth quarter with your large international Tier 1 customers. But I think overall international sales were down, almost 20% sequentially. So just wanted to clarify that comment, I know, I think in 3Q you talked about some seasonality. So I just wanted to revisit the trends of your Tier 1 in 4Q and then expectations throughout the year.

Tom Stanton

Yes, so I mean you are right, it is down sequentially. But that is what we had expected and I would say if you look at that entire market, it was probably a little bit stronger than we would have expected. But when I say good quarter, I didn’t mean that it was sequentially up. It is sequentially down, but its actually better than what we had initially planned going into the quarter and that’s really what my comment is based off of.

I would expect them; I think they are going to be like any, like most carriers. I mean we talked about seeing seasonality in that market, the same way that we typically see seasonality here in the U.S.

So I would expect then to start of a little slow in Q1, the budgets and things tend to happen towards February, kind of middle of February and then start ramping from there and I would expect the same thing here and then we would see it progress through the year and probably downtick in the fourth quarter.

Amitabh Passi – UBS

Got it. And then just – Tom maybe just a broader question in terms of any other key geographies where you are seeing an up-tick and just sort of Broadband Access deployments and maybe you can give us some sense, copper versus fiber based architectures across the globe.

Tom Stanton

Sure. So I’d like to think about our business in Europe, it’s really EMEA and we saw additional customer traction in vectoring which was good. There is interest in Active E technology and in fact we have, we are towards the tail end of trials with some carriers with Active E in the EMEA region and we’ll see that pickup next year, but predominately what we are shipping to that region right now is either VDSL2 or vectored VDSL2 and we see that shifting more and more towards vectored VDSL2.

The other strong area for us was Latin America. We have a traditional customer down there that I think more people are aware off. In Mexico we had a sold quarter with them. This quarter we expect that to actually pick up and be stronger this year than it was last year and then we had – and that is by the way VDSL2 rollout and then we saw pickup in both Latin America and here in the U.S. in fiber based technology with Ethernet running on our server actively with GPON and that was fairly, in the U.S. fairly broad based. We saw that pickup in Tier 1, Tier 2s and Tier 3s.

Amitabh Passi – UBS

Excellent. I mean just one final one for you Jim. OpEx, the last three quarters, you've held it in a very tight range. Just curious, assuming you have a pretty strong ramp in the back half, how should we be thinking about OpEx, absolute dollars, percent of sales, if you can give us some guidance there.

Jim Matthews

Well, in terms of absolute dollars in a similar range is what we are seeing in Q4 and what we expect in Q1. We don’t expect any sort of significant increase in OpEx going through the year. So you know a fairly tight range.

Amitabh Passi – UBS

Okay. Excellent thank you.

Operator

And our next question is from Paul Silverstein from Cowen and Company. Your line is open.

Paul Silverstein - Cowen and Company

Hi, I have two questions if I may. First off Jim, I take it, by virtue of your gross margin commentary, that these new Tier 1 wins in the EMEA region or Latin America that they are not coming in at meaningfully different pricing that would adversely impact gross margin, or is that not the case? And I’ve got a second question.

Jim Matthews

I think I would agree with that.

Tom Stanton

Yes, I’m familiar with the pricing and they won’t affect the gross margin profile.

Paul Silverstein - Cowen and Company

Tom and Jim, the way you’ve been thinking about gross margin going forward, has that changed at all from what you have communicated to us 90 days ago or 90 days before that? And when you talk about continued expected improvement in the second half, the magnitude doesn’t change.

Jim Matthews

No, there is really no reason for the change, so no.

Paul Silverstein - Cowen and Company

All right, and finally on the Enterprise side, I know with the global recession back in the 2010 period it might have skewed whatever seasonality if any there was, but in various years, it's been up quarter after quarter after quarter while it was growing and other years it was down in the fourth quarter. Any thoughts about, as we look at Enterprise and its growing presence, any thoughts about seasonality going forward?

Tom Stanton

That’s a good question. So let me kind of recalibrate where I believe Enterprise has been. So Enterprise was actually, it made it through the first part of the recession fairly well and was continuing to grow and then really it was 2012 that we really started seeing the impact of – kind of the environment really hit Enterprise.

This year they’ve done really well. They continue to grow through the year. We saw some softness in the fourth quarter, but that softness was very channel specific. I mentioned that our VAR channel was down and to be honest with you, I can’t tell you exactly why, because we had talked to the VARs, nothing inherently different, no really competitive environment difference. You know there is – we do have stock-in distributors. There may have been a little bit of inventory, something going on, but the environment felt the same.

So I would expect and to be on the safe side, I would expect we typically see kind of flattish going into Q1 and that’s what I would expect and I would expect it to ramp up from there. We do traditionally see a softer Q4, even for Enterprise in Q3 and I don’t have the numbers right in front of me, all you need, but we typically see that unless there’s some market share gain that happened with the carrier or something.

Paul Silverstein - Cowen and Company

Yes, and Tom if I may, it's actually – there hasn't been a consistent pattern. In some years it's been up and some years it's been down to your standard, but one last question if I might. Looking at DTs, the major carrier in Europe, I know it's still early in that deployment, but when you look at your Q3 and Q4 revenue from that carrier, and you look forward, given your seasonality comment that you expect typical seasonality, I trust you still expect overall growth when you smooth out that seasonality from here, given how early it is in deployment or has it already reached full run rate?

Tom Stanton

We definitely expect growth in year-over-year.

Paul Silverstein - Cowen and Company

Great. I’ll pass it on. Thanks guys.

Tom Stanton

Okay.

Operator

Our next question is from Simona Jankowski from Goldman Sachs. Your line is open.

Simona Jankowski - Goldman Sachs

Hi, thanks very much. I just wanted to ask you a question about your international business since it’s starting to expand very meaningfully here. Can you just go into a little more detail on the competitive landscape there? Are you typically seeing Alcatel as the main competitor? Do you ever see Calix? You mentioned you didn’t see much of Huawei, but I wasn’t sure if that was a U.S. comment versus internationally. So just would love to understand that a little bit better. And then also from a margin structure perspective, what is the delta right now in the deals that you’re signing internationally versus in the U.S.?

Tom Stanton

So, well let me cover the first piece and then we’ll see if we can cover the second piece. The first, as far as Huawei and Alcatel and Calix, so my comment on Huawei was specifically here in the U.S. I just hadn’t seen a lot of activity. Initially they were really pushing the Tier 1 carriers and then I think they rebooted and tried to push maybe some into Tier 2’s and then they were rebooting again and focusing on the Tier 3 carriers and my comment there was I just have seen the press around that, but I haven’t seen any real activity around it. So we just don’t see them much. I would say I probably saw them more five years ago in the U.S. in competitive bids than I see them today, so we’ll just wait and see how that plays out.

Outside of the U.S. without a doubt its Huawei and Alcatel-Lucent. In almost every large and in fact every large RFP that we see or project that we see, those two are in there trying to earn their piece of that particular project. So those are the two. We don’t see Calix that often. Maybe a little in the Caribbean, but we don’t really see them much outside the U.S.

Simona Jankowski - Goldman Sachs

Any comment on the margin, from the relative margin structure?

Tom Stanton

Well, I’ll take you back and hopefully Jim won’t be too upset. I’ll take you back a little bit to what our guidance was, kind of early in when we did the BBA piece and I will tell you, its not substantially changed from there. We were initially in the 30’s. That’s how they have been, to get it kind of in the mid to upper 40’s. I mean if you look and then obviously we’re on track with our target. So if you think about that, our traditional business and here in the U.S. is typically that’s given some of the broadband stimulus and stuff in the low to mid 50’s. I think that’s the right way to think about it.

Simona Jankowski - Goldman Sachs

Thank you. And then just a separate quick question. I think a couple of the push-outs that you had embedded in your guidance, when you first guided for the fourth quarter, related to a delayed revenue recognition for some BBS projects, and also a delay in the ramp of the share gains you had one at one of the Tier 2 customers. So, it sounded like both were at least partially recognized in the fourth quarter, which drove some of the better than expected trends in the Carrier Networks business. I just wanted to make sure I understood that correctly.

Tom Stanton

I think you’re exactly right. We did see a pick up I mentioned at the Tier 2 carriers. Specifically we kind of had overcome that seasonal trend and I think you pointed out the reasons for that.

Simona Jankowski - Goldman Sachs

Okay, thanks very much.

Operator

Our next question is from Tim Quillin from Stephens Incorporated. Your line is open.

Tim Quillin - Stephens Incorporated

Good morning.

Tom Stanton

Good morning.

Tim Quillin - Stephens Incorporated

With the Tier 2 share gains, as I look at the revenue by geography, the U.S. was down 3% year-over-year and I forget; I’m guessing Enterprise in the U.S. grew pretty well. So U.S. carrier probably down fairly significantly. So where are you not doing this well or where are you seeing the weakness in the U.S. service provider market?

Jim Matthews

Yes, on a sequential basis if you look at HDSL we were down.

Tom Stanton

If you look at our legacy product we saw – I mean HDSL saw a fairly big drop, which is why I specifically mentioned the revenue now associated with HDSL.

Jim Matthews

And also on the optical side although we were up, we were down sequentially there too and that’s from the U.S. based carriers.

Tim Quillin - Stephens Incorporated

Okay. So if we kind of saw for the core non-legacy service provider business in the U.S., you’d be growing that?

Tom Stanton

Well, with the exception of Optical right, because that was kind of – so I guess we’re really talking about broadband and also the Enterprise gear that carriers sell as well.

Tim Quillin - Stephens Incorporated

Okay. Maybe I’ll ask offline. Do we have to wait for the 10-K or would you be able to give us the percent of revenue from your largest customer for the year?

Tom Stanton

Well I can tell you this. We typically do talk about the number of 10% customers on the quarterly call and we disclose the annual percent in the K, so we’ll have to wait for that. But we had two 10% customers in the quarter and similar to what we saw in the third.

Tim Quillin - Stephens Incorporated

Okay, thanks. And then Jim on the tax rate, I know its pretty difficult to forecast, just because of the level of profitability at NSN, but what should we – how should we be thinking about that over the course of the year, thank you.

Jim Matthews

Yes, as we go through 2014, you know quite frankly there will continue to be some variability based on the profitability of that business, but the way I think about it is mid-30’s as we go through the year. Now that would not include the benefit of the research tax credit legislation, which has not yet been passed okay. So once that happens it should lower the rate to that point, call it low-30’s, that’s the way we think about it or I think about it.

Tim Quillin - Stephens Incorporated

Yes, great thank you.

Jim Matthews

And we’d appreciate everybody writing to the congressman to get that passed.

Operator

Our next question is from Rich Valera from Needham & Company. Your line is open.

Rich Valera - Needham & Company

Thank you. Good morning. I’m wondering if you could talk about the major pieces of your business into 1Q and which of those you think might be down since overall your expecting that flat to down?

Tom Stanton

The major piece of – when you say major, you mean – so yes…

Rich Valera - Needham & Company

Broadband access Internetworking. I think Internetworking is flat. We expect broadband access sort of flat to down and I guess the other big piece is the Optical access and then legacy, if there’s any color on the trajectory of those segments into 1Q?

Tom Stanton

To be real I’m going to say, it is hard for us to predict that. I mean we still have very much of broken chip companies, so we have significantly less than a month of backlog typically at any one point in time for coming into a quarter. So really what we look at is seasonal trends and the way we think about it is almost every product will be flat, but there is there – you know there maybe some, now it won’t turn out that way. One of them is going to surprise us on the upside and one of them hopefully will surprise us on the downside and you know depending we’ll even out the two.

There’s not any particular items that we – you have to look at it from a product basis and also from a carrier basis and carriers will start up at different periods of time within the first quarter and sometimes those change and they really don’t telegraph that they are going to start a week or 10 days late from where they did last year.

Rich Valera - Needham & Company

Great, that’s helpful. And then I know you don’t want to give too much color beyond Q1, but is there any qualitative commentary you could give on your expectations for the Broadband Access business. Obviously there is the big NSN BBA piece. Not sure how much color you have. It sounds like you have some things that maybe ramping and you move into 2Q and beyond up and then perhaps some increased activity domestically on maybe the Tier 2 side. So any sense you could give us of the business beyond 1Q, other than sort of historical typical seasonality.

Tom Stanton

If you will, let me give you the variables that we’re dealing with and then kind of let you come up with your own insight as to how that will play out. The international piece we feel, I mean the year ought to be a good year. I mean we will not only have positive momentum at the large carrier that was all talked about, but we have new awards that are coming in and people are adopting more vectoring technologies. So we see an upward profile for that business that really I think we’re measuring kind of how much of the upward profile and how quickly carriers adopt things.

In the U.S. there are a couple of big things. One is a big Tier 1 U.S. carrier. Do they continue to stay on track from a date wise and then what is the large profile in the second half and there’s variability to that. I mean Tier 1 carriers are incredibly difficult to forecast lab exit times, integration exit times and really the thing that gives us comfort is if I could make the quarters go away and just say is it going to happen and is it going to happen in a reasonable time period, the answer is yes, but whether or not that falls on a particular quarter boundary for one order or two orders to come in, it really does change the profile of things from your perspective, so that’s the biggest variable.

And then the second variable is really around the Tier 3 markets. I mean we would still consider them to be not as robust as they were three years ago or probably even two years ago. We started seeing some signs of life again. We kind of started re-spending again in the last year, but I would say, they are still not up to a healthy level and whether or not that turns on this year is probably the second biggest variable here in the U.S.

There are a lot of positive rule changes that have happened. The most recent one you mentioned in my notes happened only in December, which should relieve a lot of the angst that they have around long term larger project commitments, but is yet to be seen as to whether or not that’s really gotten any traction. So those are probably the two biggest things that gave us some question mark as to exactly what that profile would be here in the U.S.

Rich Valera - Needham & Company

That’s very helpful color, thank you, and just one more if I could on the legacy business. Could you give us your expectations for the business in ’14 that is relative to the fourth quarter run rate, which I think was a new vote for you guys. You think its sort of stable at those levels in absolute dollars or do you think we see further declines in absolute dollars as we move through 2014. Thank you.

Tom Stanton

I was just going to tell you, yes Jim wanted me to let you have this, but I think lets restate the size of kind of where we are and…

Jim Matthews

Yes, the size is definitely the prime for our quarters. I mean if we look at legacy in total, we’re about 10% of total revenues and we would expect that will continue to decline over time as the growth in our core products continues and also as the dollar amounts with each legacy areas will continue to decline through the quarter. Obviously the big drop off from the dollar standpoint is behind us, but again over the long term we expect that they will stay.

Rich Valera - Needham & Company

Okay, that’s it from me. Thank you.

Tom Stanton

Thanks.

Operator

Our next question is from Simon Leopold from Raymond James. Your line is open.

Simon Leopold - Raymond James

Thank you. I wanted to see if we could just do a quick clarification, first of all on the fourth-quarter tax rate. I think in the prepared remarks you mentioned the international mix as a key factor for that lower rate, and if you could just discuss other factors that may be playing in that?

The other thing I wanted to ask about two topics; one is, we talked a lot about our competition on this call. The one thing I wanted to check on was whether or not you're seeing Alcatel-Lucent increasing as a competitor in the Tier 2, Tier 3 space in the U.S., noting that you did talk about share gains. I was just wondering if you're seeing them as a more presence there.

And then the other thing was, I was hoping we could get some sizing around the contribution of the NSN business in the quarter, because there are a lot of moving parts here. It sounds like it was better than you expected but down sequentially. I'm just trying to get a good baseline of, is that closer to 25% of overall revenue or closer to 30% of overall revenue, and if I'm in the right ballpark on sizing that contribution in the fourth quarter? Thank you

Tom Stanton

Simon and Jim, I’ll start. So in terms of the tax rate question on Q4, we did see a sequential decline in overall revenue for the acquired business, however within that sequential decline, we had a positive mix shift in terms of customer mix, which certainly contributed towards the profitability and the lower tax rate at lower overall volumes okay. Hopefully that’s helpful for you, but I’ll…

Simon Leopold - Raymond James

Yes, I just wanted to make sure there was no other kind of one-time tax issues besides that customer issue that you did raise.

Tom Stanton

Right, well revenues although they were sequentially down did come in a little bit higher than we expected as well from the requirements, so that was somewhat helpful.

Simon Leopold - Raymond James

And then on the ALU and the NSN contributions?

Tom Stanton

So let me cover the ALU piece and I’ll let Jim cover the NSN contributions. The quick answer to your questions is no change. Well Tier 3 is definitely not a change. Tier 2, there is a constant kind of push or pressure that comes from ALU in the Tier 2 space, but I’ll say there is really no change there. It feels very similar to what it felt like a year ago.

Jim Matthews

And Simon, in terms of your question on the contribution of the overall acquired business to international, that’s not a number that we disclose, but its certainly – I would say the majority, and that’s about all I can say at this point, of the 52 million in revenue that we experienced in Q4, we did see some level of sequential increase on the organic international, but again the larger piece of international would be the acquired business.

Simon Leopold - Raymond James

And just to clarify, you talked about a Latin American customer and that customer has been buying organic products, not the acquired products, correct?

Tom Stanton

Yes.

Simon Leopold - Raymond James

Right, thank you.

Tom Stanton

Okay.

Operator

Our next question is from George Notter from Jefferies. Your line is open.

George Notter – Jefferies

Alright, thanks very much guys. I understand that a big piece of the gross margin benefit obviously came from the BBA piece, the acquisition. Can you talk about you know what you guys are doing there right now? It sounds like some of that was mix shift from what you said. Is there still more to do in terms of organic cost reductions, anything on manufacturing and then also can you kind of give us a sense for where the margins in that business are relative to corporate average. Thanks a lot.

Tom Stanton

Sure. Let me cover the first piece. So yes, there are some additional cost reductions that we have planned. In fact they were additional cost reduction plans for this year and you are correct. The cost reductions that we are seeing so far did help us in Q4.

As far as manufacturing, we are continuing to migrate additional products from current manufacturing facilities to somewhat the more Asian based manufacturing facilities and that’s a continued migration process that’s been going on for really since we acquired the business. I would say a lot of the – from that perspective a lot of the big pieces have been moved, so I would see the incremental piece on that being less than what we had seen so far to-date, but we have some major cost reductions that are on the design side that will be kicking in throughout this year. Some of them are focused specifically on Q2.

Whether we actually see this – hopefully we’ll see those in Q2. I think we’ll see that improvement in our business, but whether or not we see the full benefit from a shipping perspective is yet to be seen. But you’ll see those cost reductions still happen throughout this year and I think really as we exit this year, I’m sure you’ll see us kind of in our normal cost reduction cycle. The same thing that we do in the U.S. where you see just periodically coming out with a new generation of products. You might hear in the U.S. we’re introducing a fourth-gen OSP product that will be positive for instance to gross margins and that’s just the normal course of business that we do.

George Notter – Jefferies

Got it. And then the margin in that NSN BBA piece relative to corporate average, any sense for that? Thanks.

Jim Matthews

Sure George, and we have just addressed it with an earlier question. The acquired business gross margin is in the 40’s and the organic being in low to mid 50’s.

George Notter – Jefferies

Great, thank you.

Operator

Our next question is from Eric Ghernati from Bank of America. Your line is open.

Eric Ghernati - Bank of America

Yes, hi. Thanks for taking my questions. One clarification for you; if you were to look at your large European carrier customer that you start ramping, if you look forward, let's say exit in 2014, like what do you think the percentage of the wins that you have with them would be complete? Would you be like 50% of the way done, 60%, 70%, any color would be very helpful.

Tom Stanton

Yes, so that’s a good question. It’s a multi year project and some of it we don’t know the answer to, because some of it has to do with the success in the sales side and their sales side on being able to roll out the service and actually generate the kind of up-tick from the customer base that your looking for. But the current project as we see it defined that the league was a roughly – I’m going to say roughly a four to five year type piece. Well that’s upgrading the existing network.

Our existing installed base has kind of the tail end of that network, so right now we’re deploying new chassis and doing some upgrades in our existing base. That will continue on as kind of what I’ll think about as footprint expansion and then you’ll see them go back where we already have an installed base and upgrade that installed base with that current technology as well.

Eric Ghernati - Bank of America

So, I mean, is it fair to assume like – I mean, let's hypothetically say this is a $200 million contract. It is not one that you will see a big chunk of that revenue in 2014? It's more likely spread out between ‘14 through ‘16. Is that a roughly fair assumption?

Tom Stanton

Yes, that’s the right thing. I don’t have the exact dates, but that’s definitely the right way to think about it. There is a defined project schedule which says we are going to do these regions in this period of time, we are going to upgrade these regions in this period of time and I don’t see anything that will say 2014 would be the end point of that. It definitely goes to 2015 and I believe it goes through 2016, but I’m not sure, I just don’t have the actual dates in front of me.

Eric Ghernati - Bank of America

Okay. Thanks for this clarification. Then just a couple more questions. So it's nice to hear that you're actually working on expanding customer base of vectoring EMEA, but from my understanding, this is kind of public disclosure from Alcatel Lucent. They do generate very, very low margins on this business, somewhere like in the mid-20s. Just curious, like when you go head-to-head against them in RFPs, and you're faced with these kind of margins, how do you win against them? Is it product, is it still pricing? Just any color would be very helpful. Thank you.

Tom Stanton

Yes, so we are absolutely competing with them and I will tell you, we’re now seeing low 20’s. So and I think we just went after in securing one of the largest ones in Europe and they are by the way also in the account and we’re not paying that so far. So I think maybe the starting point is that you think that the architecture, those leads to a good cost profile when we’re competing and I will also say that we have an approach to work. If its not going to generate profit then we don’t go after that piece of business. So it maybe a little bit of a different mindset there.

As far as what we win, there are multiple things that factor into that. We have, we believe to be the broadest product line in the Broadband space as we cover all the way from our the UBE products like the smaller line count side to the curb type products, all the way up to large in the hundreds and thousands of ports of GPON or gigabit GPON or Active E.

We have a very, very broad product set. I think there are times where our competitors have to OEM a product or bring another product in order to compete and sometimes that works and sometimes that doesn’t and we pride ourselves on having very strong engineering and so we think on a feature-for-feature basis we are definitely a platform basis, we do very well.

Not all carriers care about all those features and so we don’t win them all, but I think if you would just line the products up and start checking for options, I think we would come out very well in that comparison and sometimes that’s actually against the game. Of course the third piece is relationships within the carriers and making sure that the carriers have confidence in what you can do and that was a large piece of the whole BBA acquisition and being able to get some incumbency in those relationships to help us move our products forward.

Eric Ghernati - Bank of America

Thanks and good luck.

Tom Stanton

Okay. Thank you.

Operator

Our next question is from Bill Dezellem from Tieton Capital. Your line is open.

Bill Dezellem - Tieton Capital

Thank you. I hope you didn’t address this already, but inventories, your revenues were down sequentially and yet inventories were not down much at all. And so I guess we are curious, is that a frustration on your part, not seeing that inventory fall off a little further or is that a real strong indication to us on the outside, just how big a revenue ramp you are planning for after the first quarter?

Jim Matthews

Well, this is Jim, so yeah. Inventories were down sequentially but not to the extent of revenues as you mentioned. Our turns did decline a little, but the way we think about the inventory turns as we go through this year is closer to the range of 4.5 turns, if I may leave it at that. We obviously for our comments, we do expect year-over-year revenue growth as we go through the year as well okay, so we want to be properly stocked obviously before that.

Tom Stanton

I think that’s also the way. This is Tom. I think that’s the right target. We have had turns higher and we have run into supply problems and although we don’t foresee any supply problems for many of our vendors today, third quarter is a completely different period of time and we do think it’s a good use of our cash to have an inventory level that keep us out of issues, because those issues can be very painful when they occur. So I think 4.5 turns is really kind of where we have historically found our sweet spot where we can meet customer requirements and we are not caring so much that it becomes an obsolescence problem or just kind of a wasteful use of cash.

So that’s the term we have. There is another impact there at turns. If I look at 4.5 today versus 4.5, lets say five year ago, because of the amount of project related inventory that we actually have in the filed that’s actually a tighter inventory situation that we have historically, because we have a lot that’s already shipped, but we may not have recognized yet, because the project may not be done and although that counts on their inventory turns, it really doesn‘t allow us to ship out to another customer. So we’ve had to become more efficient just to keep that 4.5 turns consistent or constant.

Bill Dezellem - Tieton Capital

That’s helpful additional information. And then just to make sure that we are, fully understanding conceptually how the year unfolds, seasonally, the second quarter will be directionally up and then the third quarter should be up further by maybe a wide margin, not only because of seasonality, but because you have your Tier 1 U.S. customer that will be ramping. Is that the right way to be thinking about the business?

Tom Stanton

We are right with you. I think its that variable with that large customer. Look I’m just kind of smiling because you don’t ever know, but that is the way we are thinking about it.

Bill Dezellem - Tieton Capital

And then I’m going to stretch this out one more quarter, seasonally off. How are you thinking about that given that ramp with the domestic customer?

Tom Stanton

I don’t know the answer to that. I think there is the potential to overcome that. I don’t want to put too much emphasis on that. It really depends on the ramp of that customer and where the exit point is from the operational development that is given today, the OS development. Without a doubt there is that potentially, but if you were to ask me today what to bet on, I’d have to fall back to history and I’d have to say seasonally we’re down in the fourth quarter and we would expect no difference this year.

Bill Dezellem - Tieton Capital

Fair enough. I certainly appreciate the color.

Tom Stanton

Okay. Steve, I think at this point we are out of time. So I do appreciate everybody calling in and we look forward to talking to you next quarter.

Operator

This does conclude today's program. You may now disconnect at any time and please have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!